The newly independent PBM Medco Health Services’ stock has been doing very well since its independence from Merck just a few months ago.  In fact if you received Medco stock at the time of the disbursement you’ll find that it’s up about 30% while Merck’s is down about 15%. There are some grumbles on the Medco message board about the management, but that’s being ignored by the market  which has bid the stock up more than $5 since Medco increased its projected earnings for next year (from 44 cents a share to between 44c and 47c).

Meanwhile competitor CaremarkRx has also seen a decent rise in its stock. It’s now back up to roughly where it was before it fell on the news that it was "overpaying" for rival AdvancePCS on September 3. On Tuesday it announced results that beat the market’s expectations by a penny. More interestingly Caremark seems to be shrugging off a recent lawsuit that claimed it misled shareholders over a settlement concerning its failed purchase of Phycor back when it was called Medpartners. Neither its stock price nor that of AdvancePCS showed any concerns that the FTC’s has made a ‘Second Request’ regarding the merger deal. While the lawsuit claiming $3.2 billion is probably a long-shot, the FTC does have to look carefully at the merger. 

Between them Caremark and Medco control a big chunk of the mail-order drug market.  If the merger goes through, Caremark’s main job is increasing AdvancePCS’ use of mail-order. Currently about 10% of Advance’s drugs go out via mail order, whereas for Caremark it’s about 40%. (Medco’s is around 33%)  Of course supplying a drug via mail-order is much more profitable than just processing the claim and having another pharmacy fill the script.  If Caremark manages to increase mail-order use, it becomes a significant lever in its dealings with both pharmacies and perhaps manufacturers, and mail-order overall will become much more significant–something the FTC will be watching. This market concetration also goes for supplying mail-order and other services in the specialty pharmacy market–usually based around drugs for specific relatively rare diseases which use a lot of expensive drugs.. The Drug Cost Management Report (full article well worth reading) notes that:

Added to this concern from the FTC is the accusation from pharmacies that Medco and other PBMs are deliberately routing scripts away from them to their mail-order businesses. Meanwhile others like health plan Highmark are getting into this business.

Meanwhile the big health plans are likely to be looking at the PBM market. Given that merger-mania and the underwriting cycle will eventually reduce the possibilities for revenue growth in that market, reintegrating health plan and PBM services must be tempting to the folks in Indianapolis and Minneapolis.  After all, it’s not as if PBMs have actually helped health plans or employers actually do what they were supposed to do over the past decade–reduce the cost of the drug benefit!

You may remember my post somewhat facetiously titled The End of Managed Care. The concept was that managed care plans had stopped trying to manage physician behavior and had given up in the face of aggressive class action lawsuits from doctors who wanted to get paid more quickly and objected to being "down-coded".

Well the lawyer behind that suit is turning his sights on the PBMs on behalf of some smaller pharmacies. The new suit filed today alleges that the PBMs are forcing patients to use their mail-order services instead of the local pharmacies (which seems likely but probably not illegal to me) and are forcing unfair contracts upon small pharmacies (which if your definition of "unfair" means "using your buying power to extract lower prices" also seems likely but not illegal). Still, worth watching this space and seeing if yet more legal antics for the PBMs actually has any effect on their business. As someone who completely underestimated the impact of the backlash against managed care, I’m loathe to say that this seemingly hopeless suit will have no impact on PBMs.

Here’s what Medco said in its IPO offering document last April:

In February 2000, two qui tam, or whistleblower, complaints under the Federal False Claims Act and similar state laws were filed under seal in the United States District Court for the Eastern District of Pennsylvania. These
complaints allege improper pharmacy practices, violations of state pharmacy laws and inappropriate therapeutic interchanges. We have not been served with the complaints and have not been required to defend against the allegations.

Well now that the US Attorney is joining the suit, it appears that the "practices" included
"Inappropriately filled prescriptions includ(ing) instances where a Medco pharmacist said he consulted a doctor but didn’t, or when a prescription was canceled suspiciously".  The stock market doesn’t seem to care, based on the fact that the existence of the suit was disclosed in the S1. However, the US Attorney is being very aggressive claiming that the government can charge $5000 for each script that was affected, and that there are thousands and thousands.  It’s worth keeping an eye on this one as PBMs may find their future in whatever comes out of the Medicare Drug Coverage bill is affected by this publicity–whether or not Medco is found guilty and fined a huge sum.

The Feds have backed two whistleblower suits against Medco.  The allegations claim that Medco used a variety of techniques to favor Merck (which owned Medco at the time) and was paid $430m in 2001 to switch scripts from Merck’s competitors. Back in March 2003, Milt Freudenheim in the New York Times highlighted Medco’s income from rebates (some $1 billion a year) and its ability to move share towards Merck’s drugs.

PBMs have for a long time made money from rebates, and have also been very economical with the truth to their health plan customers about how much they got from pharma companies for those rebates and how much was passed through to their customers.  However, during the late 1990s their performance seemed very ineffective in keeping down the cost of drugs for their plan and employer clients, either in reducing their usage or by holding down their unit price. For more of my take on PBMs see this post.

Interestingly enough, Medco’s stock price went up over a dollar in the latter part of the afternoon after 2pm when the confirmation (of somewhat old news) came out that the US Attorney’s office was joining the suit.

Today’s New York Times confirms what I said yesterday.  Caremark is paying a bit too much for AdvancePCS, but is doing so to get into the Medicare scrum as in the NYT’s words  "large drug benefit managers jockey for position in hopes of handling the potentially huge Medicare drug program that a House-Senate conference in Congress is drafting for 40 million elderly and disabled Americans." Meanwhile, Express Scripts shares have headed down to meet the percentage loss in Caremark’s since yesterday (Sept 3) morning’s deal, although there’s no clear reason why and ESRX already has a lower PE ratio than the other two. Caremark has gone down because a) they are paying too much (especially as they are debt-free and Advance still has $400m debt left over from its purchase of PCS a while ago) and b) they were growing revenues at 30% per year (and profits more so) and won’t be able to do that if they merge with as big a player as AdvancePCS — unless of course:

a) they convert many of Advance’s customers onto their mail-order pharmacy sooner than you’d expect, and/or

b) all PBMs get an amazing deal out of the Medicare Rx coverage negotiations.  I’d say that’s unlikely unless the entire bill is held up and we get an even more Republican-leaning Senate in 2005 and they don’t notice that we have a eensy teensy problem with a thing called a deficit.

For serveral weeks the odd rumor that PBM Caremark was going to buy AdvancePCS showed up in the Yahoo ADVP message board. While you shouldn’t usually trust what those boards say, this time they were right. Caremark announced a roughly $5 billion agreed bid for AdvancePCS, which sent Advance stock up from $40 to $47 and Caremark’s down from $24 to $22.  On the face of it, with a newly freed Medco the big gorilla in the marketplace, this is a decent consolidation move. Caremark is stronger in mail-order and more profitable, AdvancePCS has more lives, especialy in the health plan world, and has probably made a little more progress in the eHealth and DSM world. However, the price thay are paying is some 35% higher than AdvancePCS has ever traded on the open market, which is quite a premium — hence the decline in Caremark’s stock. Longer term it leaves three big PBM players for whatever role for PBMs comes out of the Medicare Rx bill, now in negotiations between the house and the Senate.

Looks like the PBM stocks are now taking a downward move . Express Scripts’ stock (ESRX) is under pressure partly following some comments from a short-seller in Barrons.  Meanwhile, Medco (MHS)continues upwards. Some of this is probably caused by institutions re-allocating their PBM portfolio. Medco has added about a billion in market cap since it started trading last week, and is now finally worth a little more than what Merck paid for it back in 1994–not bad when you condsider that PCS (ADVP) has still not come close to being worth the $4 billion Eli Lilly paid McKesson for it back then!

So Medco has officially split off from Merck as of this week, and is trading separately on NYSE, ticker is MHS. The stock actually rose 10% its first day adding over $600m to Medco’s market cap and (after accounting for the value of Medco shares issued to shareholders) Merck rose too! This indicates partially that institutions like the future of the PBMS, all of which have rallied slightly along with Medco. It’s worth noting that Medco’s market cap is 80% greater than that of AdvancePCS.

Meanwhile Medco has been at pains to say that it will be totally separate from Merck, and the market may be taking this to mean that it will be able to get the best deal, rather than the best deal after Merck’s need have been considered. It may also be indicative that the market believes that Medicare reform will be good for PBMs.  As I mentioned in an earlier post, that is likely but by no means certain.

Pity the poor PBM industry.  Hailed in the early 1990s as the solution to manage health care costs, bought up by the drug industry for far, far too much money in the mid-1990s, and investigated on again/off again by various attorney generals ever since over their relationships with drug manufacturers. In early 2000 due to another investigation, their stock price tumbles and one of the biggest (PCS) gets bought by one of the smallest (Advance Paradigm) at a fire sale price.  So ends the decade, but a funny thing has been happening. Remember that PBMs are supposed to be working on behalf of health plans and employers to get drug costs down.  But overall drug costs have gone up massively all this time (as have brand prices mostly due to the new blockbusters of the 1990s.). But so have the PBMs’ profits and their stock prices.

There are four main lines of revenue for a PBM.  1) Claims processing/transactions with all the formulary stuff and presumably price discounting that goes with it 2) Switching people between different drugs based on rebates from the manufacturers, and doing other drug promotions, 3) mail-order pharmacies, and 4) a loose bunch of activities some companies call health promotion, which also includes DSM, data analysis, etc. Buried somewhere in there is the level of risk they take on from their clients, although the answer seems to be "not too much". No one will give you a straight answer about what proportion of their revenue comes from which activity, which makes Sen. Cantwell (D-WA) suspicious enough to ask them to disclose their deals in the new Medicare legislation.  Until now their mail-order piece was very profitable (and supposedly is why Express Scripts’ market cap is around $5bn, Caremark’s around $6bn but AdvancePCS’ only at $4.5bn although it has far more covered lives than the other two.) Medco is being spun off by Merck next week and it also has a strong mail-order side.  Now they are also under what looks like a pre-emptive strike from the pharmacists who for some reason believe that the PBMs are using their formulary management techniques to steer business to their mail-order divisions — imagine that!

This presages the main question of what role PBMs will play in whatever eventually comes out of Congress on Medicare drug coverage. Are they going to get the biggest bonanza in their history (all those lovely seniors signing up)? Or are they going to lose all their abilities to make money the way they’ve do now, and be turned into government data processing agencies with PE ratios to match? With their stocks recently close to their all time highs, this is a space to be watched.